Seyfarth Synopsis: Under Section 604 of Secure 2.0, sponsors of 401(k), 403(b) and governmental plans may allow employees to designate employer match (including match on student loan repayments) or nonelective contributions as Roth after-tax contributions at the time they are made. This provision was effective for contributions made after December 29, 2022 (i.e., the date Secure 2.0 was enacted). Since the issuance of Secure 2.0, a number of questions relating to this optional provision have been lingering. As previously reported here, on December 20, 2023, the IRS issued Notice 2024-2 (the “Notice”) providing guidance on several provisions under Secure 2.0, including Section 604.  A brief overview of the guidance issued relating to designated Roth employer contributions is provided below. 

Are plans required to allow employees to elect to make Roth employer contributions?

No.  The Notice clarifies – as we expected – that plans may, but are not required to allow participants to designate employer matching and/or nonelective contributions as Roth.  This is the case even if the plan allows employees to make Roth employee contributions.

Do the current rules applicable to designated Roth contributions apply?

Yes, the Notice clarifies that several existing rules applicable to designated Roth contributions also apply to designated Roth employer matching and nonelective contributions. For example:

• Designations of employer contributions as Roth must be made no later than the time the contribution is allocated, and is irrevocable.
• Designated Roth employer contributions must be separately accounted for, and are not excludible from gross income.
• Employees must have the right to make or change a Roth employer contribution designation at least once a plan year.

The IRS also clarifies the term “designated Roth account” includes a separate account established for designated Roth employer contributions, so that a portion of an eligible rollover distribution of Roth amounts from another qualified plan, such as Roth employee contributions for example, may be rolled over to another account established for designated Roth employer contributions, even if the other plan does not allow for Roth employee contributions. 

Does a separate five-year period apply to Roth employer contributions?

Under current IRS rules, earnings on designated Roth contributions may be withdrawn from a plan tax free if the distribution is a “qualified” distribution.  Generally, in order to be qualified, a distribution must be made after the five taxable-year period of participation (certain other requirements must also be met). IRS rules provide that the five-taxable-year period is the period of five consecutive taxable years beginning with the first day of the first taxable year in which the employee makes a designated Roth contribution to any designated Roth account established for the employee under the same plan and ends when five consecutive taxable years have been completed.

So, if a participant has been making designated Roth employee contributions before he or she elects to make Roth employer contributions, does the five-year period applicable to his or her prior designated Roth employee contributions apply to the Roth employer contributions, or does a separate five-year period need to be satisfied for the earnings on the Roth employer contributions to be withdrawn tax-free?

The Notice does not specifically address this question. However, absent additional IRS guidance, based on existing IRS regulations, it seems reasonable to conclude that the applicable five-taxable-year period commences as of the first day of the first taxable year in which the employee makes designated Roth contributions, whether such contributions are designated Roth employee contributions OR designated Roth employer contributions.  In other words, a separate or new five-year-taxable period would not apply if the participant has previously made designated Roth employee contributions to the same plan.

What does it mean to be 100% vested when received?

Section 604 of Secure 2.0 says that in order for a participant to be eligible to designate employer matching and/or nonelective contributions as Roth, the match and/or nonelective contributions must be 100% vested when received. However, the statutory language under Secure 2.0 does not elaborate on what “100% vested when received” means.  For plans with a vesting schedule, does this mean that a participant must be 100% fully vested when the employer contributions are made, or can the election be applied only to the vested portion of the employer contribution? 

The Notice clarifies that a participant must be fully vested in the particular contribution type at the time it’s allocated to be eligible to designate it as Roth. In other words:

• A participant must be fully vested in matching contributions at the time the contribution is allocated to his or her account to be eligible to designate matching contributions as Roth.
• A participant must be fully vested in nonelective contributions at the time the contribution is allocated to his or her account to be eligible to designate nonelective contributions as Roth.

For example, assume a plan provides for both employer match and nonelective contributions. Matching contributions are always fully vested, but nonelective contributions are subject to a 6-year graded-vesting schedule. A participant may designate matching contributions as Roth immediately, but must wait until he or she is 100% fully vested after 6-years in order to be eligible to make a Roth designation with respect to nonelective contributions.

What about nondiscrimination testing?

If you’re a benefits geek like us, the vesting clarification described above raises a follow-up question. Doesn’t this create potential concerns from a nondiscrimination testing perspective? Generally, under Section 401(a)(4) of the Internal Revenue Code, a plan must pass certain tests if a benefit, right or feature is offered to some, but not all participants. 

In the Notice, the IRS confirms that “other right or feature” would include an employee’s right to designate employer matching and/or nonelective contribution as a Roth contribution, and that an exception does not currently exist. Thankfully, however, the IRS goes on to say that pursuant to its authority under the regulations, a plan will not be treated as failing to satisfy Section 401(a)(4) just because it provides that an employee may designate employer contributions as Roth only if the employee is fully vested in the contribution type at the time it is allocated to the participant’s account.

When are designated Roth employer contributions included in a participant’s gross income?

The Notice clarifies that designated Roth employer contributions are included in a participant’s gross income for the tax year in which the contribution is allocated to the participant’s account, even if the contribution is deemed to have been attributed to the prior tax year.  For example, assume nonelective contributions for the 2024 plan year are deposited to a participant’s account in early 2025, in accordance with administrative practice.  Further assume that a participant elected to designate his or her 2024 nonelective contributions as Roth.  In this situation, the nonelective contributions attributable to the 2024 plan year would be included in the participant’s gross income for the 2025 tax year, the year they were deposited to the plan and allocated to the participant’s account.

Are designated Roth employer contributions included in wages on the Form W-2?

No.  Roth employer contributions are excluded from wages for purposes of federal income tax withholding. The Notice makes clear that a participant who designates employer contributions as Roth may want to consider increasing his or her withholding or make estimated tax payments to avoid an underpayment penalty. In addition, the Notice clarifies that designated Roth employer contributions are not included in wages for purposes of FICA or FUTA. This is similar to how matching and nonelective contributions to a qualified retirement plan have historically been treated. Note, special rules apply to governmental plans.

How are designated Roth employer contributions reported if they aren’t included in wages?

The Notice clarifies that designated Roth employer contributions are reported on Form 1099-R for the year the contributions are allocated to the participant’s account, similar to the rules that currently apply to in-plan Roth rollovers. 

As mentioned above, this provision is already effective, so plan sponsors may allow employees to designate employer match and/or nonelective contributions as Roth.